Cheap Gold Stocks' Upleg Intact

Gold stocks have plunged in September, crushed by the withering selling pressure
from heavy futures shorting hammering gold. As usual, these falling prices
have kindled extreme bearishness on this left-for-dead sector. But despite
this rotten sentiment, gold stocks' young upleg remains very much intact technically.
This impressive resiliency is fueled by these miners' incredibly-cheap fundamental
valuations.

Gold stocks are without a doubt the most despised sector in all the stock
markets. Thanks to the Fed's brazen debt monetizations and manipulations of
interest rates, the global markets are distorted beyond belief. Stock markets
have soared to extreme
valuations on the Fed's implied
backstopping, leading to epic complacency, greed, and hubris. That
artificial levitation sucked vast capital out of alternative investments.

When stock markets do nothing but rally thanks to the Fed, the perceived
need for prudent portfolio diversification with alternative investments like
gold has vanished. And with investor interest in gold virtually dead, the gold
stocks have suffered mightily. Nearly everyone believes they are doomed to
spiral lower forever. To be bullish on this loathed sector guarantees ridicule
and mocking these days.

Nevertheless, a hardcore remnant of contrarian investors remains very bullish on
this sector. They have studied market history, and remember core truths that
the Fed has blasted from most minds. Markets are forever cyclical, they
rise and fall. Any extreme in sentiment and prices is soon followed by a major
reversal. Exceptionally-high greed-fueled prices soon fall, and exceptionally-low
fear-drenched prices soon rise.

Contrarians know that successful investing demands buying low then
selling high. And the cheapest stocks are always the most hated, the sectors
with the most universal and overwhelming bearishness. They have the most potential
to explode higher and multiply wealth when sentiment inevitably shifts the
other way. That's why smart investors including elite billionaire hedge-fund
managers are long gold stocks today.

Gold-stock fundamentals are exceedingly easy to understand. Gold miners obviously
mine gold. And their production costs are largely fixed when mines are built.
So their profitability is determined by the gold price. When gold climbs, their profit
margins and absolute earnings soar as their costs stay pretty stable. So
these companies are ultimately a leveraged play on the gold prices which
drive their profits.

Across all the markets, any stock's underlying profitability determines what
its fundamentally-sound price levels should be. Gold stocks are no exception,
as they will eventually climb dramatically to trade at reasonable valuations
relative to their profits. And not only will their earnings surge as the gold
price itself recovers from today's sentiment extremes, gold stocks are dirt-cheap
relative to current low gold levels!

Gold stocks are now languishing at a fraction of their fair value relative
to gold because of the epically bearish sentiment plaguing them. But such emotional
extremes never last, they are inherently self-limiting and soon burn themselves
out. When psychology in this gold-stock sector finally normalizes, the miners'
beaten-down stock prices are going to surge higher to reflect their earnings
fundamentals.

This first chart highlights today's extreme anomaly in gold-stock price levels
that was indirectly driven by the Fed's super-manipulative quantitative-easing
campaigns and zero-interest-rate policy. It looks at the ratio of gold-stock
price levels relative to the gold price that drives their profits. Since ETFs
have grown so popular with traders, I'm using the dominant American ones as
proxies for gold-stock and gold price levels.

Gold-stock prices are represented by GDX, the benchmark Gold
Miners ETF. And gold prices are represented by the mighty GLD SPDR Gold Shares
gold ETF. Dividing the price of the former by the latter and charting it over
time shows whether gold stocks are gaining or losing ground relative to the
metal that drives their profits and hence ultimately stock-price levels. This
chart is still a stunning wake-up call.

This blue GDX/GLD Ratio line is the key to understanding why contrarians remain
so bullish on such a seemingly-hopeless sector. Before 2008's crazy once-in-a-century
stock panic sucked in gold stocks, they traded at a pre-panic average GGR of
0.591x. In other words, a share of GDX was worth about 6/10ths of a share of
GLD. The epic fear generated by 2008's stock panic shattered that long-standing
relationship.

GDX plummeted 71% in a matter of months, as many if not most gold-stock investors
capitulated and sold low in the dark heart of that panic. Much like today,
bearishness was off the charts. But as Warren Buffett has wisely said, the
time to be brave is when everyone else is afraid. The greatest times
to buy low are when a sector's stock prices seem the most hopeless. With most
investors out, they are just too cheap.

In late October 2008, the GGR had cratered to just 0.227x. The extreme and
unsustainable selling that was driven by extreme and unsustainable bearish
sentiment had crushed gold-stock prices to a fraction of their fundamentally-righteous
levels relative to the metal that drives their profits. Then, like now, contrarians
like me bullish
on gold stocks were mocked. But we made fortunes as they inevitably mean
reverted.

Over the next several years, GDX would more than quadruple with a 307%
gain! Buying low pays off big. And coming out of such a crazy low-priced anomaly,
gold stocks' gains easily exceeded those of gold itself. So the GDX/GLD Ratio
blasted higher, ultimately stabilizing around 0.419x over the next two-and-a-half
years. That level is critical to remember, because it persisted during normal post-panic
years.

By August 2011 gold itself grew very overbought and overdue for a major correction,
which I warned
about right as it topped. And as usual since gold stocks are leveraged plays
on gold prices, they fell faster than gold which dragged the GGR back down.
It bottomed and reversed normally in mid-2012, but then the Federal Reserve
launched its unprecedented open-ended QE3 campaign to manipulate
financial markets.

QE3 changed everything in the markets, and temporarily destroyed the
demand for gold. Not only was the Fed monetizing bonds with new dollars created
out of thin air, it was constantly jawboning that it was ready to ramp up QE
if the economy (read "stock markets") weakened. So stock traders took this
as an implied backstop, a Fed put on stock prices. So market history
be damned, they ignored all risks to keep on buying.

Capital fled from gold to chase the levitating general stock markets, driving
a once-in-a-century gold
plunge in the second quarter of 2013. Gold stocks were crushed on this, ultimately
falling 69% from their peak on a GDX basis to hit their worst levels since
the stock panic's. But the amazing thing was the GGR actually fell to an
all-time low well below late 2008's. Gold stocks had never been cheaper relative
to gold!

This mother of all gold-stock lows happened late last year, days after the
Fed announced it was starting to slow down its massive QE3 bond monetizations.
Ever since then, gold stocks have been fighting the extreme bearish sentiment
headwinds to rally on balance. They are starting to regain ground compared
to gold, with the GGR enjoying its best rallying streak so far this year since
2010. Gold stocks have already reversed!

For 6 long years, gold stocks lost ground relative to gold. As the relentlessly-downward-sloping
GGR shows, they became cheaper and cheaper compared to their earnings power.
The GGR kept being repelled at the strong secular resistance line shown above.
But early this year the GGR made another attempt to break out to the upside,
and that finally succeeded only a few months ago this past June.

This decisive GGR breakout on top of its strong new uptrend since late
last year shows that gold stocks have reversed. The 6-year downtrend in their
prices relative to gold is over. And that makes perfect sense. The markets
are forever cyclical, no trend lasts forever. Contrary to the bears' foolish
assertions, there was just no way gold-stock prices could continue falling
compared to the driver of their profits indefinitely.

After 6 years of the GGR retreating, how long is its mean reversion from bearish
to normal to eventually bullish sentiment going to take? Several years at least,
and likely longer since great market cycles tend towards symmetry. And that's
why gold stocks are so darned bullish and exciting today. They are dirt-cheap
after years of falling out of favor, so their upside potential from here is
enormous beyond belief.

Remember that in the normal post-panic years before overbought gold corrected
and before the Fed's extreme market manipulations of QE3, the GDX/GLD Ratio
averaged 0.419x. This week it slumped to 0.199x, actually well below the worst
levels of 2008's epic stock panic. So merely for gold stocks to regain fundamentally-normal
prices relative to gold at today's levels GDX would have to surge 110%
higher!

You read that right. Even at today's dismal $1250ish gold prices, gold stocks
would need to more than double from here to reflect the metal's impact
on their profitability now. And that's a very conservative target for two reasons.
First, after such extreme bearishness gold stocks shouldn't stop rallying at
merely normal sentiment. The great emotional pendulum should swing far back
into the opposite greed side.

So at some point in the next several years, gold stocks are highly likely
to power much higher than that post-panic GGR average. They'll likely attain
the pre-panic average of 0.591x, and maybe even higher for a short spell when
euphoria flares. Second, gold itself isn't going to keep languishing near $1250.
As the Fed's artificially-levitated stock markets inevitably roll over with
QE3 ending, gold is going to surge.

Alternative investments thrive when conventional ones are struggling. So once
the lofty stock markets decisively roll over, investors will remember gold's
unparalleled value as an essential asset to diversify portfolios. Capital will
flood back in. Provocatively despite popular wisdom, rising rates will help
this. Gold
has thrived in rising and high-rate environments historically since they
hit stocks and bonds hard.

That's why I still strongly believe gold stocks are going to at least quadruple over
the coming several years again just like they did after 2008's anomalous stock-panic
low. Pick any GGR higher than the post-panic average, and a gold price way
higher than today's, and the gold-stock price targets surge accordingly. At
a 0.6x GGR and $2000 gold for instance, GDX would quintuple from today's
low levels.

Being a quasi-prominent contrarian on the stock markets and gold, my e-mail
inbox explodes whenever the former surges near highs or the latter wilts. Myopic
traders with no understanding of market and sentiment cyclicality gloat
about how stocks will rise forever while gold falls forever. What a dumb bet.
And weaker investors succumb to bearish groupthink and fret that some major
new gold plunge is imminent.

But despite all the fear and bearishness on gold and gold stocks this past
month's futures-shorting-driven selloff
has generated, its impact on the GGR is trivial. Note above that the recent
weakness in gold stocks relative to gold barely registers in this long-term
chart, and the GGR remains near both its 200-day moving average which recently
turned higher and its new uptrend's support. There is no damage.

That is true technically too. While gold stocks' dirt-cheap fundamentals are
the key reason contrarians are so bullish on them, their price action looks
fine despite the past month's selloff. This next chart looks at gold-stock
technicals through the lens of the flagship GDX gold-stock ETF. Though its
price action is a secondary concern, so many traders are worked up about this
latest selloff that it bears examination.

Despite all the sound and fury and the bears' supreme hubris this week, GDX remains
within its major new uptrend that was born almost 9 months ago in late
December 2013! Gold-stock prices are near support and look to be bottoming at
another higher low. We've seen gradual and sustained buying of gold stocks
by smart investors all year long despite the fierce headwinds from the Fed's
stock-market levitation.

GDX's 200-day moving average, which usually signals the long-term trend direction,
continues to move higher after reversing several months ago. And GDX's 50dma
crossed back above its 200dma twice this year, confirming gold stocks' Golden
Cross buy signal. There is literally nothing bearish about this chart,
it is actually powerfully bullish for a young upleg. Gold stocks continue to
advance on balance technically.

Long-term investors look to major downside fundamental-pricing anomalies to
buy low, like the GGR today reveals. But short-term speculators look at trends
and support approaches. And GDX's chart clearly shows gold stocks are at their
third best buying point since their decisive reversal late last year. Buying
when prices near support in strong uptrends is one of the best ways to make
money in trading.

Zooming out to the bigger picture technically, gold stocks have been consolidating
sideways in a massive basing formation since last summer. The second quarter
of 2013 was gold's worst quarter in a whopping 93 years, so it spawned
off-the-charts bearishness. Ever since, the vast majority of traders have been
utterly convinced that gold, silver, and their miners' stocks are doomed to
spiral lower forever.

These weathervane bearish calls couldn't have been more wrong though. Enough
buyers emerged to snatch up all the sellers' gold-stock shares, leading to
the past 15 months' bottoming consolidation zone. If gold stocks couldn't be
hammered lower with gold sentiment so epically bearish for so long, just imagine
how they will soar when psychology mean reverts out of these extremes. It's
going to be amazing.

So with gold stocks exceedingly cheap fundamentally and at an outstanding
buy point technically, what are you going to do? Have you forged yourself into
a contrarian tough enough to fight the crowd and buy low? Or are you slave
to herd groupthink? Will you buy low when a sector is deeply out of favor and
reversing higher? Or will you wait until after gold stocks already double and
miss the easy gains?

The right answers are so glaringly obvious. The high and loved stock markets
can't rise forever and are long
overdue for a serious selloff. And low and hated gold and the stocks of
its miners can't fall forever and are long overdue for a gigantic mean-reversion
upleg. With bearishness in gold extreme with it near consolidation lows, and
its miners epically undervalued, how can this not be an ideal time to buy low?

At Zeal we've always been hardcore contrarians, buying low when few others
will to multiply fortunes. So while gold stocks remain the pariah of the stock
markets, we've continued to diligently research them to prepare for their coming
massive moves higher. Just this week, we finished our latest 3-month project to
ferret out the best advanced-stage junior gold explorers. These elites have
vast upside potential dwarfing GDX's.

We started with over 600 junior gold stocks, and gradually narrowed
them down to our dozen favorites with the best fundamentals. All these winners
are profiled in depth in our brand-new 23-page report.
It is incredibly fortuitous to have one of our deep-research projects conclude
when gold stocks happen to be at a super-bullish major low. So don't tarry, buy
your new report today while these stocks remain dirt-cheap!

With the stock markets and gold at such extremes, cultivating a contrarian
mindset has rarely been more important. We've long published acclaimed weekly and monthly newsletters
to help investors and speculators like you gain that critical contrary perspective.
They draw on our decades of hard-won experience, knowledge, wisdom, and ongoing
research to explain what's going on in the markets, why, and how to trade them
with specific stocks. Subscribe
today before Wall Street fleeces you blind!

The bottom line is gold stocks remain radically undervalued relative to the
metal which drives their profits, even at today's dismal gold levels. After
falling faster than gold for 6 long years, this secular trend has reversed
over the past year. This was despite the extreme bearishness plaguing this
sector. Gold stocks' mean reversion back up to normal valuations should run
for at least several more years.

And after suffering such epic valuation anomalies, gold stocks are again due
to at least quadruple like they did after 2008's stock panic. The futures-shorting-driven
gold selloff over the past month pushed gold stocks back down to their new
uptrend's support, creating a fantastic buying opportunity. While not everyone
is smart or tough enough to fight the crowd and buy low, those contrarians
that do will be richly rewarded.

If you have questions I would be more than happy to address
them through my private consulting business. Please visit www.zealllc.com/financial.htm for
more information.

Thoughts, comments, flames, letter-bombs? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that
I am not able to respond to comments personally. I WILL read all messages though,
and really appreciate your feedback!

Mr. Hamilton, a private investor and contrarian analyst,
publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis
of markets, geopolitics, economics, finance, and investing delivered from an
explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for
more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to
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